Question

The following are the budgeted profit functions for X Company's two products, A and B, next year:
Product A: P = .42 (R) - $30,720
Product B: P = .48 (R) - $58,210
where R is revenue. Budgeted revenue for the two products are $88,000 and $88,000, respectively. Unavoidable fixed costs for the two products are $10,752 and $24,448, respectively. The company is considering dropping Product B; if it does, the resulting freed-up resources can be used to increase revenue from sales of Product A by $14,000, with no additional fixed costs.

If X Company drops B and increases revenue from A, firm profits will change by?

Answer 1

Solution:

Firm's Profit if Both products continued:

Product A = .42*(88000) - $30720 = $6,240 (Profit)

Product B = .48*(88000) - $58210 = - $15,970 (Loss)

Loss of Firm = $6240 + (-$15970) = -$9,730

Firm's Profit if Product B is dropped and Revenue from A is increased:

Product A:

Increased Revenue = $88000 + $14000 = $102,000

Profit from Product A = .42*(102000) - $30720 = $12,120

Product B =- $24,448 (Loss of unavoidable fixed cost as this product is dropped)

Loss of Firm = $12120 + (-$24448) = - $12,328

Therefore,

Change in Firm's Profit = - $12328 - (-$9730) = -$12328 + $9730 = - $2,598 (Decrease)

Hence firm's profit will Decrease by $2,598.